The Fed's Stag Party

That 70s ShowI hope Jimmie "J.J." Walker is dusting off his inflation bits, because they may soon be current again. Anyone out there ready for an exciting blast from the past? How about a little stagflation?

No? That's a bummer, Jack, because there's plenty of writing on the wall to suggest we may be heading into the glory days of the 70s once again.

6) Our government is content to not only watch this happen, but to try and divert our attention from reality by releasing insipid, partisan cheerleading like this hunk o' day-old tripe from Elaine Chao, our Secretary of Labor:

"U.S. Labor Secretary Elaine L. Chao applauded the news of the productivity increase by stating: 'Today's news is further validation of President Bush's economic policies, which continue to produce steady, consistent growth that helps America's workers. The upward revision in productivity is especially important because productivity growth is the foundation of rising wages and salaries for workers.'"

Nothing to see hereDid Chao bother applauding her department's anemic jobs report today? Of course not. That's not how PR works. Still, you have to give these people credit for one thing: They don't let little things like facts get in the way of their nice story.

The trouble is, you're probably not a government bureaucrat who draws a fat salary for putting your hands over your eyes and ears and going "Nah nah nah! I don't hear you!" (If you are, let me ask you: How do you sleep at night?) Nope, you're likely just a regular Jane or Joe, like me, trying to make smart investments. And if we're tipping toward stagflation, as we seem to be, things could get ugly for your portfolio, if not your paycheck.

The scary stag partyWhy should you fear stagflation? Because its one of those economic ills that doesn't have easy fixes. The all-powerful Fed may look completely impotent in a few months' time, and here's why. If the Fed continues tightening to try and curb inflation, it may squeeze investment, which in turn can squeeze job and wage growth.

Unfortunately, many believe it won't do anything about the inflation we're seeing. That's coming from fuel prices, and unfortunately, Ben "Fedward" Bernanke and Henry "The Treash" Paulson can do exactly zilch about that. Nope, oil and gas prices are set by a world market, and that market is under the loose control of nutjobs like Hugo Chavez; his Bolivian Mini-Me, Evo Morales; and that pugnacious fist-pounder in Iran, what's-his-name? Nukey McNuke.

In other words, someone else starts the stag party, and after that, you just hang on and hope the attendees don't dump too much beer in your stereo, because there's not much you can do to shut it down. Loose money policy would keep the prices rising. Tight money policies would clamp spending without clipping prices. So if inflation continues while Fed attempts to bridle it fail, prices will continue to outrun take-home pay.

Eventually, that will put the kibosh on consumer spending, while rising interest rates will also likely put the brakes on the easy-money home-swapping game that's floated much of our economy since we responded to the millennium's mini-recession by saying "Let's party."

Sitting out the partyHow can you ready your portfolio for such an event? Well, before we head to that, let's keep in mind that none of this is a given. On the other hand, I believe in at least taking a look at the macro trends out there, especially given the heady valuations we see on companies that sell goods people could suddenly find themselves completely content to do without.

Here's how I'd start my plan. I wouldn't go shelling out priced-for-perfection rates for market darlings like Hansen Natural (Nasdaq: HANS) or Google (Nasdaq: GOOG) . I don't think either of those companies suffers from a major business risk, but when the spit hits the economic fan, the market has a funny way of repricing companies to a more rational level, which would mean a major drop from today's prices for either of those.

Nor would I be too eager to jump in on "values" like the recently reduced Urban Outfitters (Nasdaq: URBN) . Retail is one of those risky plays when consumers consider double-knotting the purse strings, so if you play in this sector, as I do, stick with leaders. Look for strong franchises with a decent lock on their shoppers.

Something like an American Eagle Outfitters (Nasdaq: AEOS) fits the bill here, I'd argue, as well as a Chico's FAS (NYSE: CHS) . While there's no such thing as an insurmountable moat in retailing, I think American Eagle's position as an affordable brand makes it less vulnerable than its higher-priced rivals. And the women who shop Chico's are probably fairly well-insulated from the economic shocks that might have the rest of us eating ramen noodles for a year or two.

Finally, I continue to believe that the oil cycle has plenty of "up" left in it. Unlike some of our other bursting commodity bubbles, oil enjoys steady, increasing demand that will not be suddenly slaked by an increase in supply. That's why I'm following the lead of some of my oily colleagues and taking another look at energy infrastructure plays, from Transocean (NYSE: RIG) to ExxonMobil (NYSE: XOM) .

One way to avoid the coming storm (if it comes) is with stocks that are already cheap. Get a look atMotley Fool Inside Value, our premier bargain-stock newsletter, and see how grown-ups invest. All it will cost you is a mouse click.

Seth Jayson enjoys predicting doom when he's not pressed for the date and time. At the time of publication, he had shares of American Eagle and Transocean, but no position in any other company mentioned. View his stock holdings and Fool profile here. Fool rules are here.

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment icon found on every comment.